The next big economic dislocation might be only weeks away
By Chris Martenson: For years we've preached the From the Outside In
principle of markets: When trouble starts, it nearly always does so out
in the weaker periphery before creeping towards the core.
We saw this in the run-up to the housing bubble collapse, as
sub-prime mortgages gave way before prime loans, and in Europe, as
smaller economies like Greece, Ireland, and Cyprus have fallen first and
hardest (so far). We see this today in accelerating food stamp use
among poorer U.S. households. In each case, the weaker economic parties
give way first before being followed, over time, by the stronger ones.
Using this framework, we can often get several weeks to several
months of advance notice before trouble erupts in the next ring closer
to the center.
Which makes today notable, as we're receiving a number of new warning signs. The periphery is giving way.
Ever since the current economic "recovery" began, we've been warning
of the high risk of a renewed financial crisis. That risk is now
uncomfortably high. This is because nothing that led to the first round
of troubles was actually addressed at the root level. Instead, prior
troubles were simply papered over with central-bank liquidity, leaving
structural weakness intact – for instance, our ‘too big to fail’ banks are just as big, and our sovereign debt levels are even worse than they were pre-2008.
The next crisis will be larger and more damaging than the last one,
principally because nothing got fixed, political capital was spent, and
trust has been eroded, leaving everyone depleted and ready to bolt for
the financial exits.
With the periphery failing, we likely have only weeks – perhaps a month or two – until the next big dislocation hits.
Déjà Vu (All Over Again)
We’ve been here before. We’ve seen trouble start on the outside and progress inwards, and not all that long ago.
In 1999 and 2007, we saw the financial markets blithely trundle along
higher, even as clear signs of trouble at the margins were abundant.
One of the common myths about the stock market, often repeated in the
press, is that it peers into the future. The market is the 'great
discounting machine.’
But the stock market powered higher into the new millennium, despite
being the most overvalued it had ever been in history, before diving
violently in 2001. So much for peering into the future.
And again, the stock market went to new heights in 2007, even as the
housing market was obviously deteriorating and about to suffer a truly
historic break after an unprecedented and bubbly run to the upside. The
great discounting machine ended up reacting to trouble rather than
anticipating it.
Despite these two obvious failures, many still hold to the belief
that the stock market is a useful indicator of future health or
distress, which means this view is more a matter of faith than fact.
My view has always been that the stock market is a 'great liquidity
detecting machine’ – something that fits the data very, very well – and
that it’s reacting to liquidity in the system more than anything truly
fundamental. This has not always been the case, but ever since
Greenspan opened the Federal Reserve printing presses to each and every
minor financial sniffle in the mid-1990s, Fed-supplied liquidity has
been the dominant driver of equity prices.
To tilt the conversation slightly, one of the enduring mysteries to
me is how we have managed to experience not one, not two, but three full
bubbles in the space of less than 15 years. Tech stocks, then housing,
then all stocks and bonds; three bubbles, each bigger than the last.
As I have written extensively in the past, the current all-time highs
in both bond AND equity prices (with bonds collectively including
everything from 1-month T-bills to the worst junk paper you can buy), is
nothing more and nothing less than the biggest financial asset bubble
in history.
In order to believe this will all turn out well, you have to believe
that this time will be different…not just a little bit different, but
180 degrees away from literally every single other financial bubble in
all of history.
This is precisely what is being asked of us each day by the financial
press, the Fed, the Bank of Japan, the European Central Bank (ECB), and
the politicians in the Western power centers.
Our view here is that it’s never different. To that we’ll add:
- A crisis rooted in too much debt cannot be ‘solved’ by creating more debt.
- Prosperity cannot be printed out of thin air.
- Rigged systems and markets destroy trust.
- Nothing can grow exponentially forever, except for the number of zeros printed on your currency.
Collectively, the above list boils down to Anything that cannot go on forever...won’t. [credit: Herb Stein]
Deficits and Debts Do Matter
Deficits don’t matter! Dick Cheney once famously growled,
putting to words the belief system that envelops the U.S. today,
especially its financial and monetary authorities. Because we’ve
managed over the past three decades to dodge any serious consequences
from racking up debts, these folks believe that will always be true.
Absence of evidence becomes evidence of absence.
Sticking just to the economic “E” (leaving aside energy and the
environment), our diagnosis of the current difficulties is simply that
the OECD economies left reason aside and instead embarked on a sustained
period of borrowing at a rate nearly twice as fast as underlying
economic growth.
That is, we collectively fell for the idea that one could simply
borrow more than one earned...forever. I'm always surprised by how an
entire culture can collectively believe in something that no individual
would ever hold to be true.
We know that we cannot individually borrow more than we earn
forever. And we are equally sure that this remains true if we pool ten
people together. But we accept the idea that a sovereign nation can
somehow magically pull this off. This either represents a profound
inability to apply logic, or a form of cultural schizophrenia, or both.
Hot-Money Bubble Dynamics
For years now, ever since the Fed et al. embarked on the global
rescue plan that involved little more than flooding the world with
historically unprecedented amounts of freshly printed money (a.k.a.
“liquidity”), that money has been sloshing around looking for things to
do.
With interest rates on ‘safe’ investments at 0% (or close enough),
that hot money has been looking for anything that resembles a decent
yield. This ‘yield chasing’ went to every corner of the globe and piled
into any and every market that it could.
Some of these markets were the headline U.S. and European equity and
bond markets, and some of them were so-called 'emerging markets,' such
as Brazil, India, Thailand, the Philippines, and Indonesia.
As this hot money flowed into these emerging markets, the respective countries – in order to prevent their currencies from rising too much – did the usual and recycled the money-flows back into U.S. Treasury paper, German Bunds, and other sovereign debt instruments.
Now, all of this is being undone.
It is a hot-money machine running in reverse, and it is creating the
usual distortions, difficulties, and hardships for the afflicted
countries. Currencies are plummeting, as are local equity and bond
markets.
In short, to understand where our financial markets are and where
they are headed, you don't need to know much about fundamentals at all.
Earnings, GDP, job growth, etc. are secondary to liquidity flows. That’s why the various markets are so keyed on the Fed’s next statements and when and how extreme the ‘tapering’ might be.
That’s all that really matters.
Well, that’s not entirely true. For reasons that cannot be entirely
explained nor controlled, sometimes bubble dynamics just end. People
stop believing. And what was once a virtuous cycle suddenly morphs into
vicious one.
I believe that’s the moment where we are now. And, as always, it's starting from the outside in.
In Part II: Blast Shields Up! Prepare for Incoming!
we look at the growing number of klaxons warning that central bank
policies to prop up the global economic system are failing at an
accelerating rate.
There are many fronts on which this losing battle will be fought, but our biggest concerns lie in the bond markets – ultimately and including U.S. Treasurys.
Defensive maneuvers are the name of the game now for the prudent. Make sure you're one of them.
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